OLD BANKS, NEW TRICKS. De: Silver-Greenberg, Jessica, Francis, Theo, Levisohn, Ben, BusinessWeek, 00077135, 8/17/2009, Fascículo 4143
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OLD BANKS, NEW TRICKS
Lenders haven't sworn off risky financial products--they've just come up with different ones
That didn't take long. The economy hasn't yet recovered from theimplosion of risky investments that led to the worst recession in decades--and already some of the world's biggest banks are peddling a new generation of dicey products to corporations, consumers, and investors.
In recent months such big banks as Bank of America, Citigroup, and JPMorgan Chase have rolled out newfangled corporate credit lines tied to complicated and volatile derivatives. Others,including Wells Fargo and Fifth Third, are offering payday-loan programs aimed at cash-strapped consumers. Still others are marketing new, potentially risky "structured notes" to small investors.
There's no indication that the loans and instruments are doomed to fail. If the economy keeps moving toward recovery, as many measures suggest, then the new products might well work out for buyers andsellers alike.
But it's another scenario that worries regulators, lawmakers, and consumer advocates: that banks once again are making dangerous loans to borrowers who can't repay them and selling toxic investments to investors who don't understand the risks--all of which could cause blowups in the banking sector and weigh on the economy.
Some of Wall Street's latest innovations give reason for pause.Consider a trend in business loans. Lenders typically tie corporate credit lines to short-term interest rates. But now Citi, JPMorgan Chase, and BofA, among others, are linking credit lines both to short-term rates and credit default swaps (CDSs), the volatile and complicated derivatives that are supposed to act as "insurance" by paying off the owners if a company defaults on its debt. JPMorgan,BofA, and Citi declined to comment.
In these new arrangements, when the price of the CDS rises--generally a sign the market thinks the company's health is deteriorating--the cost of the loan increases, too. The result: The weaker the company, the higher the interest rates it must pay, which hurts the company further.
The lenders stress that the new products give them extra protection againstdefault. But for companies, the opposite may be true. Managers now must deal with two layers of volatility--both short-term interest rates and credit default swaps, whose prices can spike for reasons outside their control.
Making matters more difficult for corporate borrowers: high fees. Banks are raising their rates for credit lines across the board--but the new CDS-based credit lines cost far more thanthe old lines. FedEx could end up paying $1.9 million to $3.6 million a month if it decides to tap a new line from JPMorgan and Bank of America. On its previous line with JPMorgan, FedEx would have paid about $540,000.
Yet many companies have little alternative. With corporate credit remaining tight, banks increasingly are steering borrowers to the CDS-linked loans. All told, lenders have handedout nearly $40 billion worth this year--roughly 70% of the total in credit lines extended to borrowers in fairly good standing. That's up from around 14% in 2008. FedEx, United Parcel Service, Hewlett-Packard, and Toyota Motor Credit have all taken the plunge. "It wasn't our idea," says a UPS spokesman. "The bankspulled back from offering set rates."
At the other end of the borrower spectrum, bigbanks are entering another controversial arena: payday loans, whose interest rates can run as high as 400%. Historically the market has been dominated by small nonbank lenders, which mainly operate in poor urban centers and offer customers an advance on their paychecks. But big lenders Fifth Third and U.S. Bancorp started offering the loans, while Wells Fargo continues to boost its payday-loan...